Index Fund Investing in the Blockchain Space

In our previous blog post, we discussed how to measure crypto investment success. If you haven’t read it make sure to follow up on it:

In that post, we highlighted that with a portfolio consisting of Bitcoin and Ethereum you are able to track the performance of the total cryptocurrency market capitalization fairly well.

In order to construct such a market portfolio, you simply allocate your investment according to the relative market capitalization of Bitcoin and Ethereum. Based on November 2020 data that portfolio would consist roughly of 85% Bitcoin and 15% Ethereum.

In order to understand the importance of Ethereum in your portfolio, it is worth noting that the performance of Ethereum has been a very good proxy for the performance of altcoins in general.

Index Fund Investing in the Blockchain Space

Index Funds

Index Funds are a great idea in theory. However, almost none of the large exchanges have listed all cryptocurrencies and therefore none of them can offer you a portfolio that represents the entire market.

Index trackers such as Coinbase Bundle entered this niche but have failed. The reason they did not succeed was that their altcoin allocation was predominantly invested in Bitcoin and Ethereum forks that were listed on Coinbase but underperformed the overall market.

Furthermore, index funds typically invest in the 10 or 30 largest cryptocurrencies. However, the highest valued cryptocurrencies are extremely volatile and therefore the ranks are changing at a tremendous speed. For these reasons, the ten largest cryptocurrencies of today might look completely different in a year’s time.

You may be knowledgeable enough to pick the right coins that will outperform the market but most people won’t achieve that just as it is the case with selecting individual stocks.

If you still want an active investing strategy and recognize you won’t have the skills to beat the market yourself, platforms like Iconomi offer you to invest based on the strategies of others.

Unless you want exposure to a certain vertical such as Decentralized Finance or to follow the strategy of a professional investor it is best for the average investor to stick with Ethereum and Bitcoin if your target is just to grow your investment with the market.

Passive Investment Strategies

In the following, we are going to explore which options you have for passive investments and automated purchases.

Passive investing implies that you acknowledge that you can’t time the market. Therefore it is best you set up recurring payments. Recurring payments are offered by the largest cryptocurrency exchanges such as Binance and Coinbase.

Binance for example allows you to purchase cryptocurrencies on a daily, weekly, or monthly basis with a number of different payment alternatives.

Setting up your Passive Investment Strategy

Let’s assume you want to follow our recommendation and invest 100$ every month into the cryptocurrency market.

In this case, you would simply set up monthly recurring buys for 85$ of Bitcoin and 15$ of Ethereum on Binance.

Make sure that from time to time you remove your assets from the exchange and store them on a hardware wallet such as a ledger.

What is the big advantage of this strategy? You are able to control your own coins and to remove them from the exchange. You, therefore, have no counterparty risk or exposure to potential hacks of the exchange.

In case you would hold a crypto index that is managed by an exchange, your investment depends on the solvency of the exchange.

Targeting Market Niches

What if you would like exposure to certain industry verticals such as Decentralized Finance but you don’t want to incur the hassle and the fees for purchasing individually every single DeFi coin?

In September 2020, Set Protocol and DeFi Pulse launched a new index fund called DPI (DeFi Pulse Index). DPI is offering investors exposure to a range of DeFi projects through one single token. The index is reweighted at the beginning of every month.

The launch came right after the peak of the latest DeFi boom in summer 2020. In the meantime, the token has lost considerable value. Investors can now buy the DPI token for 80$ at a discount of around 35% compared to the token launch in September.

Although not perfect, the DPI index might be an acceptable substitute for individually investing in the DeFi space. Furthermore, its issuance is decentralized.

Remember that investments in market niches are much riskier and therefore should only represent a small fraction of your overall market exposure.

Before You Go…

We hoped you enjoyed our advice for building and applying passive investment strategies in the cryptocurrency space.

If you have any questions make sure to join our Telegram group and participate in the discussion.